KEYS TO KAMs ACCOUNTABILITY. WHAT CAN WE GLEAN FROM THE FIRST ROUND OF ENHANCED AUDITOR REPORTS AND KEY AUDIT MATTERS (KAMs)?

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1 REPORTING BY THE ACCOUNTANTS TODAY EDITORIAL TEAM KEYS TO KAMs WHAT CAN WE GLEAN FROM THE FIRST ROUND OF ENHANCED AUDITOR REPORTS AND KEY AUDIT MATTERS (KAMs)? THE first quarter of FY2017 has passed, and public-listed companies (PLCs) are starting to lodge the first batch of enhanced auditors reports incorporating key audit matters (KAMs) with the Bursa Malaysia. Hence, it is timely to assess how auditors and PLCs are complying with the enhanced auditor reporting standards which became effective for audits of financial statements for periods ended on or after 15 December Communicating KAMs are now part and parcel of audit life, said Simon Tay, Executive Director, Professional Practices & Technical, MIA. Auditors of listed entities must address KAMs and this should enhance the information value and relevance of the audit report and provide greater insights on the audit of financial statements. In the meantime, markets and regulators are waiting to see how Malaysian auditors and PLCs manage KAMs in the real-world environment and not just in dry runs. MIA s annual AuditWorld 2017 canvassed insights on KAMs and the initial Malaysian experience at an expert panel session - Communicating Key Audit Matters & Experience Of Early Adopters In Audit Reporting. We curate the panellists thoughts: 46 ACCOUNTANTS TODAY MAY / JUNE 2017

2 KEYS TO KAMs KAMs IMPROVE STAKEHOLDER COMMUNICATIONS, AUDIT VISIBILITY Regulators across the region shared their views that enhanced auditor reporting and KAMs will improve communications between auditors, shareholders and the investing public, said Alex Ooi Thiam Poh, Director, Audit Oversight Board. Investors may liken audit to a black hole as they are unfamiliar with the auditors thought and work processes. Pauline Ho, Assurance Partner, PricewaterhouseCoopers Malaysia figured that KAMs would raise auditor visibility and provide more insights to the investor community. Auditors already provide substantial information to those charged with governance (TCWG) on risk assessment, audit approach and audit findings behind closed doors, but these are not shared with investors. KAMs are a good opportunity for auditors to provide some visibility to investors, and an avenue for further discussion with TCWG so they appreciate what we actually spend time doing in more detail. We finally have a formal way of communicating with stakeholders through KAMs, agreed Tang Seng Choon, Head of Audit & Assurance, BDO Malaysia. ENHANCING AUDIT QUALITY, REDUCING AUDIT RISKS The process of enhanced auditor reporting and KAMs will necessitate auditors to understand their clients and industries in an in-depth manner and will sharpen auditors focus on how they address significant matters. Left to right: Simon Tay, Tang Seng Choon and Alex Ooi Thiam Poh. KAMs are a good opportunity for auditors to provide some visibility to investors, and an avenue for further discussion with TCWG so they appreciate what we actually spend time doing in more detail. Pauline Ho Assurance Partner, PricewaterhouseCoopers Malaysia Although disclosure and audit quality are poised to escalate, the audit process and methodology are unchanged. The difference is that whatever you present is now open to the public. Your thought process and work process could be the same, but be more careful when presenting points and ensure that the audit documentation and procedures performed suffice the International Standards on Auditing (ISA) requirements, cautioned Seng Choon. Another pertinent difference is that audit partners, particularly those signing the audit report, must be handson and fully engaged throughout the entire audit process. If you are an audit partner and you are not involved in the whole audit process it is very difficult for you to issue an opinion and to talk about the KAMs, said Alex. Alex cautioned against boilerplate reporting which adds little value to users of financial statements. He emphasised the importance of documenting the auditor s thought process in the working papers to understand how they identify significant risk areas for disclosure as KAMs. DISCLOSURE Auditors should rely on their professional judgement and auditing standards to drive KAMs, and not be constrained by pressure to disclose certain KAMs or set a limit on the number of anticipated KAMs, stressed Alex. Always be guided by the overarching question: How does your thought process identify the areas of concern and subsequently narrow these down to matters that need to be disclosed in the KAMs? At the time of writing, the first few reports lodged with the Bursa Malaysia disclosed a minimal number of KAMs. MAY / JUNE 2017 ACCOUNTANTS TODAY 47

3 KEYS TO KAMs UK TRENDS Enhanced Auditor Reporting Findings from the UK s Financial Reporting Council (FRC) revealed that on average, UK companies reported three to four KAMs across industries in their first year of compliance with enhanced auditor reporting standards. The exception was oil and gas, which reported an average of seven KAMs in the first year due to economic volatility. Across industries, the biggest suspects are areas requiring professional judgement by auditors, impairment of goodwill, taxation, forecasts, accounting for revenue, provisions, special transactions such as acquisitions and disposals during the year, said Simon Tay. Perusing some of the UK audit reports, Tang Seng Choon, Head of Audit & Assurance, BDO Malaysia, found that the later reports released for FY2015 and mid-june FY2016 became more concise and direct. This could be ascribed to reporting fatigue as markets became intolerant of the bloated and repetitive audit reports published in earlier periods, for example, FY2014. UK reporters also deviated from reporting very general audit risks recoverability of receivables, impairment of assets and goodwill - to more specific and sophisticated KAMs. Possibly, as management took steps to rectify the areas of focus, these generic KAMs were eventually dropped by auditors. Seng Choon observed that the number of KAMs in the UK was declining but conversely becoming more difficult and industry-specific as auditors sought for more esoteric points to raise, for example, complex revenue recognition issues. It s a virtuous circle KAMs will produce more sophisticated and knowledgeable investors who in turn will become more vigilant and demanding. Here in Malaysia, the same scenario is likely to emerge as investors and stakeholders become familiar with KAMs and auditors A UK Snapshot Most common risks (percentage of total samples analysed by the FRC that reported these risks): > Impairment of goodwill (43%) > Taxation (43%) > Accounting for revenue (42%) > Other asset impairments (29%) Other risks described in the auditor s report > Provisions (approximately 28%) > Acquisitions and disposals (approximately 23%) > Pensions (approximately 20%) Source: Financial Reporting Council (FRC) - Extended auditor s reports: A further review of experience seek to surface more detailed risks. They (shareholders) will compare companies in similar industries, and as they go from one company s AGM to another, they will compare why certain KAMs are highlighted in one company but not the other, predicted Alex Ooi Thiam Poh, Director, Audit Oversight Board. 48 ACCOUNTANTS TODAY MAY / JUNE 2017

4 KEYS TO KAMs DEALING WITH DISAGREEMENTS Drafting the KAMs can be another challenging process rife with external and internal disagreements. KAMs and audit reports may differ between firms and even between partners of the same firm, because approaches and writing styles vary. Asked about BDO s approach to drafting, Seng Choon said that the first step would be to have a clear conscience as to which assertions would have significant audit risks and require significant judgements of the auditor. If you are clear in your mind as to what are the significant audit risks and KAMs relating to these risks, no reasonable Audit Committee chairman or technical persons can disagree and rebut your findings. Another concern is to pitch disclosure at user or stakeholder level. KAMs that are too generic and jargon-laden will confuse the stakeholders. Use plain English, and make KAMs concise and precise, said Seng Choon. Audit reports originating in some of the foreign countries commonly employ the phrase challenge management Another concern is to pitch disclosure at user or stakeholder level. KAMs that are too generic and jargonladen will confuse the stakeholders. Use plain English, and make KAMs concise and precise. Tang Seng Choon Head of Audit & Assurance BDO Malaysia. assumptions to demonstrate auditor independence and clarify the auditor s role, but clients in Malaysia might be taken aback by this foreign-style bluntness for the first time in our local reporting scene, related Seng Choon. The technical team will also need to check whether such choice of language is consistent with the ISAs. Another key consideration will be to enhance disclosure in financial statements, especially in areas involving judgment and estimates which will be included as KAMs, cautioned Pauline. In the same vein, Alex advised auditors to check for management s significant estimates and judgements disclosed in the financial statements and consider if these should be disclosed as KAMs. The management discussion and analysis (MD&A) should also be consistent with the KAMs because these go hand-in hand, he added. Above and beyond their job, many auditors reported requests from Board Audit Committees to record the outcome of audit procedures or conclusions on KAMs, but this does not fall within the scope of ISAs. It should be noted that KAM disclosures are not piecemeal audit opinions. To address this concern, Board Audit Committees can disclose the outcomes of KAMs via its own Audit Committee report. This could form part of the Board Audit Committees disclosures on how significant matters highlighted in the financial statements have been addressed, a disclosure requirement recently introduced by Bursa Malaysia. GROUP AUDITS AND KAMs Group audits add another layer of complexity to the already complicated process of enhanced auditor reporting MAY / JUNE 2017 ACCOUNTANTS TODAY 49

5 KEYS TO KAMs and KAMs. Under ISA 600 Group Audits the lead auditor has ownership of the whole Group audit and cannot delegate responsibility for KAMs to the component auditors. According to Seng Choon, BDO s approach guided by ISA 600, is for the lead auditor to provide the Group perspective to component auditors and introduce potential or likely KAMs at Group level to the component auditors. This follows by continuous engagements with the component auditors throughout the audit to identify and understand the KAMs. At the audit completion, the lead auditor will assess the materiality of the KAMs reported by the component auditors, if any, at Group level. In circumstances where no KAM has been reported by the component auditors, the lead auditor will do additional audit procedures to assess that there is actually no KAM being identified. For best results, lead auditors should engage with component auditors, client management and TCWG as early as possible in the audit planning stage and throughout the process. Communications should be open throughout and intensify towards the final stages of audit work, recommended Pauline. In a worst-case scenario, the lead auditor might even have to proceed to the subsidiaries local jurisdictions to engage with respective client management, TCWG and component auditors to assuage concerns. In close call situations, auditors need to see whether matters affecting going concern are adequately disclosed in the financial statements to rationalise not mentioning any material uncertainty in relation to going concern in the audit report. Simon Tay Executive Director, Professional Practices & Technical, MIA GOING CONCERN The enhanced audit reporting standards also emphasise issues affecting going concern, for which TCWG is responsible. If there are no specific disclosures on going concern in the audit report, the standards give guidance on enhanced disclosure in the financial statements. In close call situations, auditors need to see whether matters affecting going concern are adequately disclosed in the financial statements to rationalise not mentioning any material uncertainty in relation to going concern in the audit report, said Simon. Close calls are less frequent in a real life situation, but going concern situations could become more visible in the current challenging economic environment, as stakeholders demand more from auditors reporting. For example, in a rising interest rate environment, undercapitalised companies using short-term financing to buy long-term assets while relying on recurring fixed income from these assets to service the borrowings could face increased liquidity and cash flow risks and warrant enhanced disclosures. COMMUNICATING KEY AUDIT MATTERS & EXPERIENCE OF EARLY ADOPTERS IN AUDIT REPORTING was the focus of an expert panel at MIA s annual AuditWorld 2017, which seeks to share the latest developments in audit and their impact on audit quality, corporate governance and markets. Disclaimer: The views expressed are those of the speakers and do not necessarily reflect the view of their respective organisations. 50 ACCOUNTANTS TODAY MAY / JUNE 2017